New working paper: Fungibility and the choice of aid modalities

Leiderer, Stefan:
Fungibility and the choice of aid modalities: the red herring revisited
UNU-WIDER Working Paper 2012/68
ISBN: 978-92-9230-531-4

The ‘right’ choice of instruments and modalities to provide aid to developing countries in support of poverty reduction and economic development is arguably one of the most contested issues in the current international debate on aid effectiveness.

It is a common perception among many policy makers, but also aid practitioners, that there exist fundamental differences between aid instruments and modalities with respect to the fiduciary risks they involve. A particular controversy exists around the provision of aid in the form of budget support to avoid high transaction costs and other shortcomings of traditional project-based aid. Critics argue that this kind of ‘programme aid’ involves unacceptably high fiduciary risks due to the fungibility of budgetary funds. As a reaction to this criticism, a more recently proposed approach is in the form of results-based aid or aid on delivery such as the World Bank’s ‘Programme for Results’ or the ‘Cash on Delivery’ approach proposed by the Center for Global Development. Proponents of these approaches argue that they provide donors with better control over the use of aid resources.

In his UNU-WIDER working paper "Fungibility and the coice of aid modalities: the red herring revisited", German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) researcher Stefan Leiderer compares project aid, general budget support and aid on delivery in a principal-agent framework with asymmetric information. The analysis shows that that in the absence of transaction costs, for a wide range of combinations of aid dependency and recipient government commitment to reduce poverty, all three forms of aid are equivalent with regard to fungibility and fiduciary risks.

The paper proceeds to demonstrate that as long as donors can rely on the recipient government to be at least minimally committed to poverty reduction, a well co-ordinated modality mix of general budget support and aid on delivery does not bear higher fiduciary risks than project aid. It concludes that if project aid does indeed involve higher transaction costs than budget support, donors should provide aid in the form of such a modality mix, albeit only if they are able (and willing) to closely co-ordinate their support.

The paper thus has a clear policy message: Donors should worry less about which aid modality to choose over the other, and much more about taking seriously the coordination and harmonization principles they have committed themselves to in the various high level declarations on aid effectiveness.


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